Opinion
Docket Nos. 6906 6907.
1945-11-27
FRANK R. MALLOY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.EVELYN MALLOY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
H. E. Kleinecke, Jr., esq., for the petitioners. D. Louis Bergeron, Esq., for the respondent.
Petitioner and his father had conducted an undertaking establishment in partnership for a number of years. The father died and by will left his interest in the partnership to petitioner, subject to a bequest to his widow of the sum of $250 per month to be paid out of one-half of the net income of the business, and provided that if said income were insufficient, the payment should be reduced to one-half the income but should be cumulative and payable out of said income if and when earned. In the taxable years payments were made to the widow under the terms of the will and corresponding deductions were taken in computing the community income of petitioner and his wife. Held, that the bequest to the widow of a portion of the income from the testator's share in the business gave her an interest in the property itself and that the payments to her, which were only a reasonable return on the capital investment, constituted income to her growing out of her interest in the property. The sums are therefore to be excluded from the gross income of petitioners. H. E. Kleinecke, Jr., esq., for the petitioners. D. Louis Bergeron, Esq., for the respondent.
Deficiencies in income tax for the calendar years 1940 and 1941 in the respective amounts of $132.82 and $664.06 for each petitioner are in issue in these proceedings. The deficiencies result principally from the disallowance by respondent of a deduction in each year for amounts paid under the terms of the will of Frank P. Malloy to his widow in determining the net income from the business of petitioner, Frank R. Malloy.
We adopt as our findings the facts which have been stipulated by the parties. In summary they are as follows:
FINDINGS OF FACT.
The petitioners, Frank R. Malloy and Evelyn Malloy, are, and at all times material herein have been, husband and wife, residing together in Galveston, Texas. They filed separate income tax returns on the community property basis with the collector for the first district of Texas.
Frank R. Malloy (hereinafter referred to as the ‘petitioner‘) was the son of Frank P. Malloy, now deceased. In 1928 petitioner's mother, the first wife of his father, died, and in 1930 the father remarried. At the time of the father's second marriage, father and son were operating the firm of Malloy & Son, an undertaking establishment.
On and prior to June 30, 1939, petitioner had a one-eighth interest and his father a seven-eighths interest in the firm. On July 1 of that year petitioner acquired by gift from his father and his stepmother, Catherine Malloy, an additional three-eighths interest, so that thereafter petitioner and his father each had a one-half interest in the business and each was entitled to half of the net income thereof as the community income of himself and his wife.
Frank P. Malloy, the father, died testate in Galveston County, Texas, on February 17, 1940. His will, which was duly probated in the County Court of Galveston County, Texas, reads in part as follows:
II
I give and bequeath to my beloved wife, Catherine Malloy, the Packard sedan automobile now used in the funeral business of Malloy & Son, or such other car as I am using for family purposes at the time of my death. I also give, bequeath and devise unto my beloved wife the property now used by my wife and myself as our homestead in the City and County of Galveston, Texas and known as 2309 39th Street, including the furniture and other household effects contained therein. I also give and bequeath to my beloved wife the sum of $250.00 per month to be paid her by my beloved son, Frank R. Malloy, out of one-half of the net earnings of the partnership firm of Malloy & Son after proper deduction is made for taxes, depreciation, bad debts and the usual operating expenses, such payment to be paid to my wife by my said son on the 1st day of the month following my death and on the 1st day of each month thereafter as long as my wife shall live and as long as she remains my widow. In the event one-half of the net earnings of the firm does not amount to $250.00 per month, in that event only one-half of the net earnings, as aforesaid, shall be paid to my wife. However, the payments of $250.00 per month or portions thereof not so paid shall be cumulative and paid out of one-half of the net earnings of the firm, as aforesaid, if and when made. In view of the foregoing bequest and the fact that I have caused certain insurance policies to be made payable directly to my wife as beneficiary I request that my beloved wife accept this bequest and the proceeds of said insurance policies in lieu of any possible community interest which she has or may have in the residue of my estate.
III
I give, bequeath and devise to my beloved son, Frank R. Malloy, all of my interest in the partnership firm of Malloy & Son, including the community interest of my wife therein, if any, and including all of my interest and the community interest of my wife, if any, in and to the West one-half of Block 210 in the City and County of Galveston, Texas, together with all improvements thereon and all other assets pertaining to said business as reflected by the books of the firm, whether the same stands in my name individually or otherwise.
I direct and request that the Executor of my estate collect the proceeds of all insurance policies payable to my estate and out of such proceeds pay, discharge, and liquidate the indebtedness of the partnership firm of Malloy & Son and I give and bequeath unto my beloved son, Frank R. Malloy, the balance of the proceeds of said insurance policies, if any, and I direct and request that my Executor pay said balance to my said son as soon as the indebtedness of the partnership firm of Malloy & Son has been liquidated.
On March 1, 1940, Catherine Malloy elected in writing to take under the will of her deceased husband and to accept the legacies under its terms in lieu of any possible community interest she had in her husband's estate.
The community interest of Frank P. Malloy and his wife at the time of his death included earnings of the partnership firm since July 1, 1939, and not withdrawn, amounting to $6,701.89.
As of February 17, 1940, the firm of Malloy & Son owned assets of the book value of $149,411.31, had liabilities of $65,688.50, and a book value net worth of $83,722.81, of which $43,904.92 was the capital account of the father and $39,817.89 was the capital account of petitioner. On the same date the fair market value of the assets was $130,297.29, and the actual net worth $64,608.79, of which $34,347.91 was the capital account of the father and $30,260.88 the capital account of petitioner.
Since February 17, 1940, petitioner has operated the business as a sole proprietorship, Frank R. Malloy, d.b.a. Malloy & Son.
During the year 1940 petitioner paid Catherine Malloy 10 monthly payments of $250 each, aggregating $2,500, and during 1941, 12 like payments, aggregating $3,000. These payments were made to her out of the business and did not in either year exceed one-half of the net profits thereof. The amounts were charged to the payee's account on the books and were reported by her as gross income in her individual returns, as an annuity from Malloy & Son.
In the returns of petitioner and those of his wife for the years in issue the net profits from the business were reported as community income, less the sums of $2,500 and $3,000 paid to Catherine Malloy in the respective years.
Respondent determined that the amounts of $2,500 and $3,000 paid to Catherine Malloy did not constitute allowable deductions in the respective years in computing the taxable net income for those years.
OPINION.
ARUNDELL, Judge:
On behalf of the petitioners it is contended, pursuant to an issue raised in the pleadings, that the sums paid to Catherine Malloy in accordance with the terms of her deceased husband's will did not constitute income to the petitioners. Respondent's principal argument is that the sums are not deductible as ordinary and necessary business expenses. We need not decide, however, whether technically the sums constitute proper deductions for ordinary and necessary business expenses because, if petitioners are right in their contention that the sums are not income to them, then of course the amounts should be excluded from their gross income in determining their tax liability.
Frank P. Malloy, by his will, gave and bequeathed to his wife ‘the sum of $250.00 per month to be paid her by (his) * * * son, Frank R. Malloy, out of one-half of the net earnings of the partnership firm.‘ The money was to be paid her for life if she remained unmarried. It was provided, however, that if one-half of the net earnings of the firm did not amount to $250 per month, then only one-half of the net earnings should be paid to the wife, but the sums were to be cumulative and paid out of one-half of the net earnings if and when made. She elected to take under the will and made no claim, to any of the property under the community property laws. The will provided that all of decedent's interest in the partnership not disposed of to his wife should go to his son.
The respondent's theory is that the payments to the widow of Frank P. Malloy were capital expenditures made by petitioners to acquire the testator's interest in the partnership. In cases where surviving partners have acquired a deceased partner's interest in the partnership pursuant to contract, in consideration for the payment to his widow of stipulated periodical sums, it has been held that such payments constitute capital expenditures which are neither deductible by the surviving partner nor excludible from the distributive share of partnership income. Autenreith v. Commissioner, 115 Fed.(2d) 856; Edwards v. Commissioner, 109 Fed.(2d) 757; and Scott v. Commissioner, 29 Fed.(2d) 472. These are the cases upon which respondent relies.
In another case the taxpayers were devisees of certain real property, which included a hotel. The testator in his will bequeathed annuities to his widow and his daughter and provided that the annuities should be a charge upon the property devised to the taxpayers. The taxpayers formed a partnership to operate the hotel. Under the law of the jurisdiction the taxpayers, having taken the property charged with the annuities, became personally liable for the payments without any relation to the income of the property. It was held that the payments were not deductible from partnership income because they were made by the partnership in discharge of the personal obligations of the partners. Commissioner v. Smiley, 86 Fed.(2d) 658.
Petitioners rely upon James M. Hutchinson, 11 B.T.A. 789, and Julian L. Hamerslag, 15 B.T.A. 96, in each of which the taxpayers inherited a going business from their father, subject to the payment of certain sums to their sister or sisters under the terms of the testator's will. In the one case the sums were to be ‘taken out of the business‘ and in the other they were payable ‘out of the revenue of said business.‘ We held in Hutchinson that the portion of the profits paid to the sister under the terms of the will did not constitute taxable income to the taxpayers, and in Hamerslag that the payment to the sister was a fixed charge upon the business and its revenues and was deductible from partnership income in determining the distributive shares taxable to the partners.
In the instant case the testator's gift of $250 per month to his widow was definitely dependent upon the income from his share in the business. It was payable only out of one-half the net income, and in the event one-half the net income did not amount to $250 in any month, the payment was to be reduced accordingly. At his death he owned a half interest in the business, worth approximately $34,000. That capital was a material income-producing factor in the business, and the payment of $3,000 to his widow in any year was not an unreasonable return on the investment.
In no proper sense can it be said that these payments were capital expenditures made by the petitioners to acquire Frank P. Malloy's interest in the business. Petitioner Frank R. Malloy acquired the interest not by purchase, but by bequest, and he took only what the testator's will gave him. The payments to the widow were not the personal obligations of the petitioners. They were but a conduit or at best agents for the payment to the widow of the bequest to her. If the testator chose to give his son something less than all his interest in the business and to give his wife a part of it, that was his privilege. In effect, that is what he did. The bequest to testator's wife and the income from his share of the partnership property were completely interdependent. In substance, the bequest was a portion of the net income from that particular property, which, in equity, would ordinarily be treated as giving her an interest— a sort of life estate— in the property itself. See Irwin v. Gavit, 268 U.S. 161; cf. Commissioner v. Terry, 69 Fed.(2d) 969.
We conclude that the payments to the testator's widow constituted income to her growing out of her interest in the business, and that they were not income to the petitioners. The sums of $2,500 in 1940 and $3,000 in 1941 which were paid to and reported as gross income by Catherine Malloy in her individual returns are therefore to be excluded from the gross income of petitioners in computing their tax liability.
Decisions will be entered under Rule 50.